The output gap: what is it, how can it be estimated and are they fit for policy makers' purposes?

The Scottish Fiscal Commission (SFC), as part of its statutory remit to produce forecasts of the Scottish economy and revenues from devolved taxes, provide assessments of Scotland’s ‘output gap’, which in turn are derived from estimating ‘potential output’. The evolution of potential output and the output gap play key roles in any assessment of the current position of the Scottish economy, and in turn the outlook for future economic growth and tax revenues. This article looks at these concepts in more detail. In what follows we explain the concept of the output gap, its relevance to policy, how output gaps in a given economy can be estimated and why the estimates are always uncertain. We then discuss current views on the evolution of the UK’s output gap and the SFC’s estimates of Scotland’s output gap and end by discussing whether estimates of the output gap currently tell policymakers what they really need to know.